This is a great guest post from Ali at Hipster Investments.
I love reading about Ali’s real estate investing and her travelling. Definitely check her blog out!
Use an Investment Partner for Rental Properties?
Sure, why not. I did.
The biggest challenge to real estate investing, for most, is finding the money to invest in the first place. I heard a flipper one time tell me that a real estate investor’s full-time job is finding money. It’s not the process of flipping the house, or finding the properties, or selling them, it’s finding the money! He said it is never-ending and you have to always be looking for more. My theory is the most creative financiers are the biggest winners in real estate. A lot of investors will debate the use of leverage, versus using all of your own money, but there are a lot of arguments against that. The only one I will bring up here is- what if you don’t have any money to invest? In that case, leveraging is better than nothing!
So how can you leverage? There are the obvious ways like taking a mortgage and using seller-financing (who doesn’t love seller-financing!), but what about more creative ways? There are hard money loans and private loans, but those are often expensive. Ever thought about using an investor partner? You may have, but you may not have known how exactly to structure the partnership.
A Structure I Learned from a Random Investor
I was at a conference in Las Vegas and I met an investor from Miami. In random conversation, more related to commercial deals than residential, I had asked him how I could entice an investor partner to put up the money on a deal and how that deal could be structured. He said, “Easy. The investor puts the cash down, from the profits you give him 30% off the top and then split the rest with him 50/50 until his money is paid back, and then you just split the profit 50/50 without anything off the top.” What investor wouldn’t go for that? I thought he had a point.
When I started getting into residential real estate properties, I immediately remembered this guy’s advice. It sounded great and just what I needed! Until I ran the numbers. Turns out, 30% off the top doesn’t quite work on smaller properties with smaller margins. It was only going to put me in the hole. Now what? After inquiring with a couple mentors, we figured out how to structure a partnership fairly given what numbers we had to work with. It was so straight-forward!
The Partnership Agreement
We thought about, what did each of us bring to the table? My investor had the cash and I had the ability to take the mortgage. Add me doing all of the work, this suddenly seemed like an even split to me! I save him one of his mortgage allotments, I take on all the risk, I do all the work, and he only has to contribute $15k-20k per deal on high-return rental properties. He makes his money back in 7 years and the rest is shear profit, including any profit from a future sale. Bingo!
How we did it:
He put all of the cash down required to buy the property, which was 20% down plus closing costs. I took the mortgage in my name (his name was nowhere on the property so the only risk to him was his capital investment), and I did all the work as far as hiring inspectors, due diligence, contract work, signing papers, talking to the team members. After that, the agreement was to split the net, whether profit or loss, 50/50. And that’s what we do today. Unfortunately we’ve gotten to experience splitting a loss on some of the properties but that’s okay because the problems have been fixed and we are back on a path to positive cash flow.
A summary of the partnership:
Investor = puts in down payment and closing costs = 50% of the effort to buy
Me = takes mortgage, assumes all the risk, does all the work = 50% of the effort to buy
Us splitting the effort 50/50 (we think it’s 50/50 at least) = split net profit (or loss) 50/50
Each month I do up a statement with the expenses and income from each property and do a bank transfer with his profits. Not going to lie, that process has become quite a pain in the neck for me each month, but every time I cringe at having to deal with it I remind myself that I am making infinite returns on these properties!
Can it Work for You?
That is the most basic investor partner structure I can see. It can work for anyone. Well, as long as one of you has the cash and the other can take the mortgage. The only other thing I suggest of course is to not just do this with anyone. My investor partner has been a closer friend for over ten years, probably the most trustworthy guy I know, and I feel confident about us doing business together. I recommended suggestion too is to go ahead and get a legal agreement written out between the two of you that clearly spells out the terms of the arrangement. Also, make sure you investment partner is set to inherit the property from you should anything happen to you. With his name not being on the deed or mortgage anywhere, no one will know about his investment in the property should something happen to you and I can only assume he would want the property. So make sure that is spelled out somewhere.
Remember, it’s not a question of whether you can do something or not, it’s a question of how to do it!